2019 Paper 2 Flashcards
(5 cards)
With reference to Extract A, explain the role of forward markets in currencies. (5)
The extract states currency has a big impact on our business and the margins we can obtain, [Ap] and that forward contracts enable institutions, businesses, and individuals to lock in an exchange rate over a certain period of time [Ap]. Forward markets allow firms to agree a fixed price to purchase foreign currency [K] at a time in the future so they can reduce the risk of fluctuating prices and predict their costs with greater certainty
With reference to Extract A and Figure 1, examine the likely impact of the change in the sterling exchange rate on the UK economy. (8)
One impact could be higher cost-push inflation [K]. Figure 1 shows that the pound fell from approximately $1.48 before the Brexit vote in 2016 to approximately $1.30 after [Ap]. The depreciation makes imports more expensive, so costs will be higher for firms increasing cost-push inflation [Ani
Another impact could be export-led growth [K]. Extract Arefers to “the pound’s post-Brexit referendum depreciation” [Ap]. This would make exports cheaper to foreign buyers, increasing the value of exports in AD leading to economic growth in the UK economy [An]
However, the extent to which inflation rises depends on how reliant the UK is on importing raw materials [E] and the magnitude of growth depends on how price elastic demand is for UK exports
With reference to the last paragraph in Extract C, assess the impact of a fall in real incomes on subjective happiness. (10)
An increase in real income can improve subjective happiness as it allows individuals to spend more on goods and services that enhance their standard of living [K]. Higher income can reduce financial stress, making it easier to afford necessities and discretionary items. The data supports this, showing that those earning over £40,000 reported a happiness score of 7.29, which is higher than those in the £10,000-£40,000 range [Ap]. This suggests that increasing income can lead to greater well-being
Another reason higher incomes may boost happiness is by reducing financial anxiety [K]. Those with more income are less worried about repaying debts or affording essential costs, which can lead to lower stress levels. Higher income also allows individuals to save for the future, improving financial security. This aligns with the data, as people earning below £10,000 had a happiness score of 7.31, slightly higher than those earning £10,000-£20,000 (7.02), possibly because those on very low incomes qualify for welfare support
However, money is not the only factor affecting happiness [E]. Leisure time, social relationships, and job
satisfaction may be more important for well-being than income [E]. For instance, high-paying jobs can be stressful, potentially lowering happiness levels despite higher earnings [E]. Level 2 E
Additionally, survey data on happiness may not be entirely reliable [E]. Self-reported happiness is subjective and can be influenced by temporary emotions rather than long-term wellbeing
With reference to Extract C, discuss the potential conflicts between macroeconomic objectives when the central bank attempts to control inflation (12)
To control inflation, the central bank would use contractionary monetary policy by raising interest rates [K]. The extract states that in 2017 the Bank of England intended to “raise the reserve ratio, relative to all assets, from zero to 0.5%” [Ap]. This would lead to banks
“becoming less willing to lend to consumers” [Ap]. With less lending, consumption would fall, which would lead to a fall in AD from AD, to AD, [An].
This would help to reduce the price level in the economy from PL1 to PL2
[Anl but would conflict with the macroeconomic obiective of economic growth because real national output falls from Y1 to Y2
However, the biggest influence of consumption in AD in the UKis household real disposable income [E].
If this is rising then consumption may not fall significantly as a consequence of rising interest rates [E]. The purchasing power of consumers and other components of AD, such as investment and government spending could be rising which may offset any falls in consumption [E]. This means the fall in economic growth might be insignificant
Increasing interest rates to reduce inflation can negatively impact employment [K]. Higher interest rates make borrowing more expensive, reducing consumer spending and business investment [An]. Labour is a derived demand so this may lead to firms cutting jobs, increasing unemployment [An]. The UK recorded its lowest unemployment rate since 1975, so raising interest rates to tackle inflation could reverse this trend [Ap].
This follows the Phillips curve trade-off, where lower inflation often comes at the cost of higher unemployment
However, the Phillips curve trade-off has significant limitations because it only holds true when the cause of inflation is purely demand-side reasons [E]. In recent years the UK has had both low inflation and low unemployment because supply-side policies used by the government has assisted economic growth and employment whilst keeping inflation close to the target of 2%
Discuss whether providing substantial government financial support to banks is the best policy response during a financial crisis. (15)
One argument in favour of providing substantial government financial support to banks during a financial crisis is that the economy is dependent on a stable financial system [K]. If banks fail, businesses may struggle to access credit, reducing investment and causing widespread job losses, which could push the economy into a deep recession [An]. The UK government’s decision to bail out Lloyds and RBS following the 2008 financial crisis helped restore confidence in the financial system and prevent a total collapse of the banking sector [Ap]. Without intervention, the risk of a full-scale depression would have been much higher
However, bailing out banks carries a significant cost to taxpayers [E]. The £65 billion bailout of RBS and Lloyds Banking Group increased the UK’s national debt, which may take years to repay [E]. This places a financial burden on future generations, reducing the government’s ability to invest in other essential services like healthcare and education
An alternative policy response could be central bank intervention, such as cutting interest rates or providing emergency liquidity support, which can stabilise the financial system without requiring direct government bailouts [K]. Expansionary fiscal policy, such as government spending on infrastructure and tax cuts, could stimulate demand and restore business confidence, helping the economy recover from a financial crisis [An]. The Bank of England’s decision to cut interest rates to 0.5% in 2009 was an example of this approach being used alongside bank bailouts to encourage borrowing and investment
However, not supporting banks could lead to a total collapse of the financial sector, causing a much deeper recession [E]. Additionally, alternative policies like fiscal stimulus take time to implement, while bank bailouts provide immediate stability [E]. If governments had allowed banks to fail, consumer and business confidence would have collapsed, worsening the crisis
